Tuesday, August 17, 2010

Even if the volume goes to zero we can still hang out here right? I mean, we don't want to let these awesome leather couches go empty...

There have been some articles recently about the plight of brokers in both Dubai and Abu Dhabi. Initially these were reports of how volumes were tapering off as we move into Ramadan. While business networking takes off during the Iftar hopping season (I wish there was an analog to this in the West) trading on the regions exchanges tends to slack off. This volume decline and the economic effect it is having on the brokerage industry in the Emirates has attracted the attention of both Bloomberg and The National as well it should because it says something about Ramadan, more about the brokerage industry in Dubai and a great deal about what the function of equity markets in the region is and what it could be.

There are any number of reasons why people would want to scale back their trading during Ramadan. Perhaps in the same way that you shouldn’t go grocery shopping while you’re hungry maybe you shouldn’t go stock shopping while you are denying yourself basic sustenance. Maybe that dry feeling you get in your mouth when you’re betting the ranch on Saudi Livestock is particularly arid when you can’t drink anything till sundown. Or maybe people feel closer to Islam generally and so are less comfortable making or taking non-Sharia compliant margin loans. Perhaps the speculative nature of trading GCC shares seems a little too close to gambling for people to be comfortable during Ramadan. Perhaps the generally higher level of sobriety keeps people away from buying shares. Or maybe this year as Ramadan falls in August everyone is simply in Marbella or the Cote ‘d Azure or Geneva so no one is around. It’s been interesting to watch the number of people logging onto my blog from the marina in Monaco spike. Whatever the reason, volumes are seasonally light.

The articles in the press don’t stop there. Volumes in the Emirates have fallen off a cliff putting an extremely serious squeeze on the brokers forcing a great many of them to close their doors. Personally I have mixed emotions about this. I think I met with 80%-90% of the brokerages in existence between 2005 and 2008. The market structure was extremely fragmented, there were something like 95 brokers registered on the DFM and the largest one had a market share of under 15% the top ten were less than 30%. As a person trying to sell connectivity to the DIFX in November of 2005 this was deeply tragic because it meant I literally had to meet with everyone.

Things got better once my firm established our own market access business which we used to connect international investors to local markets channeling billions of dollars from abroad into local markets (this ended in tears I'm afraid.) At our peak we were trading between 10-15% of the daily volume in Dubai, Abu Dhabi, Qatar and Bahrain. It sounds crazy I know, but we were. International investors could not get enough of the place once upon a time. Naturally we became an extremely large brokerage client and that made the meetings a lot easier. They got easier still in the run up to the DPW IPO. It’s always easy to have a meeting with someone when you’re paying 10% of the brokerage in the entire market and you are handing out IPO candy.

So in this way I became acquainted with the entire brokerage industry in Dubai and Abu Dhabi and let me tell you there was quite a variety. There were several which operate efficiently with a wide range of services and had moved from being mere brokerages to full service local investment banks. There were some firms which focused on electronic execution of their client orders some of which had developed surprisingly sophisticated technology in house and which we viewed as potential partners. There were of course the brokerage arms of the large banks which thanks to their huge distribution networks were printing money. We had such confidence in these firms that we were able to put them together into a retail syndicate for the DPW IPO which in all operational respects was handled as if it were a major market IPO. Though these firms were pleasant to work with they were not the most interesting stars in the UAE brokerage constellation. Those were the bucket shops.

One of the trading classics is a book called “Reminiscences of a Stock Operator” a thinly disguised autobiography of Jesse Livermore. He began his career in bucket shops. Bucket shops purported to be brokerages but never actually executed client orders on the exchanges. Rather they operated as casinos where the “house” took the other side of every trade and the margin rules were such that the clients were systematically wiped out. Despite or perhaps because of this the bucket shops became a place where local men would come to socialize and talk about stocks cheer each other on and share their sorrows. Like a casino it was as much a social activity as an economic one. Eventually in the US the authorities caught on that these were merely casinos operating incognito and shut them down. Not so in Dubai. In Dubai they multiplied like rabbits.

I must have visited several dozen during my time there. Occasionally they would be in office parks but my favourites were the ones in out of the way places: above an auto-repair shop, in the back room of an auto-dealership, behind a narrow door in a rabbit warren of alleyways in Bur Dubai or Deira. The kinds of places that when you ask the cab driver for them you get that Pakistani look of bewilderment, followed by desperation, followed by resignation that these foreign idiots have asked for yet another non-existent address and are going to go ballistic when the meter runs out of digits because it cannot be found. When you finally did find the place it was always the same thing.

There would be an extremely affable GM who would be calling you “habibi” before even shaking your hand. He would talk about the massive expansion he was planning, about how his firm would be the next EFG, Rasmala, you name it. These people drank the Dubai cool-ade by the gallon. Dubai would be the next Singapore and after that New York and it would be done by firms like his led by men like him. He’d introduce you to a few clients all of whom he assured you may not look like much but this was because they were overly modest in keeping with the tenets of Islam. This one here owns 3% of Emaar, that man in the shabby dishdash negotiating with the teaboy routinely flips millions of shares of Arabtec. Unbable to contain himself he’d insist on giving you the grand tour and show you what luxury you yourself might be able to trade in if you became a customer.

There would be at least one, often several strikingly beautiful receptionists, Arab girls from Morocco or Lebanon. I remember thinking that the Niqab made some sense because if Arab women were all like this it would be understandable that Arab men would be perpetually at war with each other over them. You would then go into the main room which would have plush carpeting and huge comfy leather sofas, a lot of fancy trading screens and TVs tuned to CNBC Arabia or Bloomberg TV. There would be tea boys and waiters aplenty to bring you some coffee or a snack to maintain that trading stamina. Some were built like nightclubs with an exclusive VIP area for the “whales” with even comfier sofas, more tea boys and gaudier decoration. There was even one, now defunct, that had a shark tank in the middle. “Our clients are the sharks of the market.” Said the GM. That may be, but they were sheep for the shearing for the brokerage.

These weren’t bucket shops in the traditional sense where house bet against the customers and rigged the leverage to blow them out. They did however achieve largely the same effect with high fees and by using the rumour mill to generate high trading volumes. My first boss on the Merc floor had a saying which seemed to me pretty useless at the time: “Bulls and bears make money, sheep get sheared, and pigs get slaughtered.” If the customers were the sheep the brokers themselves were the pigs. They ground up the clients and now the clients are gone and with them the volumes. But this is a tiny part of the story. The bankruptcies of the bucket shops and the demise of their denizens are merely a symptom of the deeper illness that afflicts the equity markets in the GCC. The real problem is not that a few impresarios have perverted the capital markets in order to separate a lot of fools from their money. The problem is that economically that is the only function they perform.

As I have written before the IPO market is a rigged game designed to spread the wealth of the business owning class to the masses. As a result all the IPOs are systematically underpriced and thus no rational business person would voluntarily sell equity in a profitable business via that method. This reinforces a cultural aversion to surrendering control or giving up equity, particularly among the merchant families. As a result the public equity markets in the UAE do not perform the important capital raising function that they perform elsewhere with massively negative consequences for the economy of the Gulf as a whole. It is impossible to exaggerate the degree to which this weakens the economy of the gulf because it forces all the merchant families to fund themselves with debt or with retained earnings. To some extent this is offset with government largesse but that creates a dependence of the merchant families on the ruling family. This suits the ruling family just fine but helps explain why there are so few globally competitive firms which originate in the Arab world.

Even once corporations are public GCC equity markets don’t provide a decent valuation function. There is no operational capacity to borrow or lend shares so it is impossible to short them. What you get as a result are a string of euphoric manias followed by buyers strikes which lead to collapse. This is why you can have things like Aabar and Kingdom trade so far away from the value of the underlying assets they own. They don’t function as a market for control either. Especially where the state takes a view as to what the outcome should be. Think of the decision of Sheikh Mohammed to form a national champion with the forced merger of National Bank of Dubai and Emirates Bank. The merger was announced before the terms were decided. The shareholders? No say. The original Arabtec merger? Abu Dhabi decides it wants something, it gets it. The shareholders? No say. The Aabar delisting? IPIC and then ESCA make arbitrary decisions, the shareholders? No say. Want to try to take out a local company as an international player? Forget it.

So the macro bulls and the bears are kept out of the equity markets in the GCC. This leaves pigs and sheep for the sharing and the slaughter. And maybe, before long, not even them.

Tuesday, August 10, 2010

UAE Banking Stress Tests brought to you by the shadow central bank: Shuaa Capital

When I first saw an article calling for stress tests of the Gulf Banks I laughed. My opinion was that the Western Governments that had enacted them largely to try to counter the market suspicion that despite the massively unpopular but massively necessary injections of capital that the banks were still in serious trouble. Knowing that they would struggle to muster the political will to rescue the banks again they decided to try to show the world that no more injections would be necessary and then market confidence might build on itself. It seems to me that this is totally unnecessary in the Emirates.

Given that the Emirates were unwilling let Dubai World fold, what are the odds that they’ll let the banks collapse? Zero. More to the point, since the banks will ultimately rely neither on the markets nor the voters for their rescues what is the point of reassuring either as to their health? At the end of the day the largesse which rescues the banking system will come from the Al Nahyan who answer to neither and indeed answer to no one. Thus rather than a statistical shock to the values of the assets on the balance sheets of the banks what a would-be stress tester would have to determine was the odds of the various banks winning the coin toss of Al Nahyan support. Given the fact that they allowed Dubai to pour $15 billion into the Nakheel black hole my guess is the coin they’ll use for banks has heads on both sides.

Apparently the UAE central bank agrees with my conclusion if not my reasoning and has decided not to conduct these stress tests. So it has fallen on the shadow central bank of the UAE, Shuaa Capital, to conduct them. I should say that I have a lot of respect for Shuaa. When I first got to the Gulf I tried to work out partnerships with a lot of local institutions whereby my firm would provide intellectual capital and they would provide the local connections. At the time intellectual capital was rarer than local connections so the deals I struck were generally pretty favourable. When I met with Shuaa they sent me packing. They had intellectual capital in spades which they showed me over the next two years as one of our stiffest local competitors for the equity market access business. They had a vastly more nuanced understanding of the legal and regulatory environment. They knew, in a way that my compliance department in Frankfurt could never know, that you can cross the lines but you can’t cross the men who draw the lines. They were a well led and effective firm.

They’re no fools with regard to how they played the stress tests either. The headlines in all the newspapers about it read in one form or another: “UAE Banks well capitalized.” I’m sure that the rulers and the regulators read that with pleasure which should serve the partners at Shuaa well indeed. Add to this the fact that the UAE Central Bank is now off the hook and it’s quite the coup indeed. Having read about them in the papers I was tempted to dismiss them but they’re pretty interesting and reward a good read. Despite my general scepticism of stress tests generally I think Shuaa did a good job. I could pick nits with their methodology. For example they limited themselves to loans made at the peak of the real estate bubble which is a de facto assumption that real estate prices which will not continue to decline, a precarious assumption in my view. I don’t want to go into the minutia of the tests but rather point out some features that I find salient.

The first thing I find interesting is that the headlines about bank solvency are a bit misleading. On the one hand they rightly make the point that the capital requirements of the UAE are more stringent than those of Basel II and that under none of their scenarios do the banks violate the Basel II capital requirements. They go on to say that under most scenarios the banks they survey are “on average” adequately capitalized but only “on average.” In every scenario at least one of the banks (ADCB) requires additional capital. Under their worst case scenario several do, up to $4.3 billion. They then say that this is well within the power of the authorities to commit to the recapitalization of the banks. Their confidence therefore is not necessarily in the banks themselves but rather in the governments’ willingness to supply that capital. I agree with this but it is not the same thing as saying the banks are well capitalized.

What I find more interesting than the report on whether the banks are adequately capitalized or not are the diagnosis of the problems which are affecting the UAE economy and the prescriptions for how the government can use the banking system to reverse them. First off they point out that the economic recovery in the Emirates has been sluggish and they lay the blame for this at the feet of the banks on account of the fact that their provision of credit to the private sector has fallen off a cliff. They point out that the banks have already been recapitalized once with an injection of cash from Abu Dhabi and a blanket guarantee on deposits. They then show that since the bailout the banks have focused on lending to the government or to government controlled entities. They then bravely assert that this is not evidence of risk aversion on the part of the banks but rather that the banks are owned by the government or allied families and they are consciously directing the flow of capital to themselves.

They then go on to describe two courses of action for the government to take to free up lending. The first is a more aggressive recapitalization of the banking system. They look at the Spanish and the Irish examples and strongly prefer the Irish case wherein the government swapped its own paper for the distressed assets held by the banks, effectively simultaneously recapitalizing and de-risking them. This is all well and good but it seems to me to not really go to the core of the problem. If the main issue is that the government and the merchant families are directing lending to their own enterprises then why would recapitalizing the banks change that?

I personally think that the main issue is neither that the banks lack sufficient capital nor that what capital is available is being directed to the government. Those two things may be true but the real problem is most likely that the excesses in the real economy and asset prices that had been built up in the system from 2005-2008 have still not yet been worked out. You can see this from the recent Aabar downgrades. Though I do not doubt the influence of the ruling and merchant families over the direction if credit flows I do actually think they are likely driven by risk aversion as much as by command.

To this end I think Shuaa makes a more effective recommendation when they suggest deep structural reform which would encourage private and foreign investment into the Emirates. Unfortunately all they do is use the favourite buzzwords for this “transparency” and “improved governance” without making any specific recommendations. I can understand why they keep it general rather than specific. This is because everyone knows what has to be done, but nobody wants to do it. This is because the only way to create a stable and predictable environment in which to deploy capital would require submitting the law of the ruler to the rule of law. No more arbitrary arrests of out of favor burecrats, no more turning a blind eye to local merchant families who rob investors blind. So far the powers that be have not connected the dots between these structural problems and the lack of access to capital but they are there.

Shuaa says some brave things in their report about the solvency of the system and the degree to which it actually responds to the market. They hint at what really needs to be done but don’t spell it out. Once again Shuaa crosses the line without crossing the men who draw the lines.

Wednesday, August 4, 2010

“The Barazi Bruiser” encourages the "DIFCI Demon" to settle, or vice versa

When Muhammad Ali converted to Islam it was controversial. Ernie Terrell, an opponent, kept calling him Cassius. In 1967 Ali beat the hell out of the guy while yelling at him the whole time “What’s my name fool!?! What’s my name!?!” Ali, who won 2/3 of his fights by KO, never delivered a knock-out blow but rather won by decision. It’s been speculated that he did this in order to deliver a longer beating. As I read the Barazi response to the DIFIC counterclaim I imagine his attorney Imran Shafiq shouting “What’s my name fool!?! What’s my name!?!” at his computer while they delivering a solid beating to the DIFCI case all the while keeping his knock out blows in reserve.

The Barazi response opens with a description of Barazi’s background demonstrating that he is eminently qualified for the roles he held at DIFCA and DIFCI. It then goes into the detail of his compensation and his contract reaffirming what his salary was, its compensation, his entitlement to severance. Nothing too exciting. It begins to get interesting when it quotes the DIFIC Articles of Association to make the point that the Governor of the DIFC who is also the Chairman of DIFCI, that is to say Dr. Omar, who has the final say in the management of DIFCI and all other managers are appointed by and subject to his authority. This will be important later.

Next they use inconsistencies in the accounts of the DIFCI managers and the DIFCI counterclaim to shred the chronology and legality of DIFCIs actions in placing Barazi on the “investigative leave” and refusing to pay him. I highlighted some of this in an earlier post but the attack Shafiq launches is far more compelling and better researched. His alternate narrative is backed by quite a bit of documentation and a great many quotes from DIFC laws and DIFCI employee manuals. The core of the argument is that the claims of DIFCI are based on a manual that was not in force at the time of Barazi’s dismissal.

In the narrative that emerges, the people who took over the DIFC after Dr. O was forced out wanted to get rid of the old guard in a hurry. It looks like they did this without fully consulting Barazi’s contract, the DIFC employment laws or the DIFCI employee handbook. I have some sympathy with this, the guys who took over had bigger fish to fry and probably figured that they would get Bisher out of the way ASAP and cross the t’s and dot the i’s later. They didn’t count on Barazi trying to shake them down for $500,000. If they had left it at that and just disputed the circumstances of his unpaid leave then we would be having a boring discussion about which version of the employee handbook is relevant. They didn’t stop there.

No they went the extra mile and rather than debate the minutia of DIFC employment law their line of argument was that Bisher had been engaged in a fraud, or series of frauds and therefore was entitled to precisely zero and, sooner or later, would probably find himself standing tall before the man. Of course once you accuse someone in Dubai publicly of fraud they know what happens next and they’re going to pull out all the stops to defend themselves which is what Barazi and Shafiq do in their response.

The first thing they do is point out that KPMG has its own reservations about the investigation and that the allegations of the DIFCI are being made on preliminary reports all of which are heavily qualified by KPMG. Then the go after each item in particular.

At the very beginning of the discussion of the “fraudulent bonus” of 2007, they make reference to the fact that The Governor of the DIFC could award bonuses at his sole discretion. This was clearly a major error in the design of the governance of the DIFC but Barazi correctly points out that “Mr. Barazi was not responsible for the system by which such responsibility and accountability lay in the Governor alone.” Quite right, my guess is the governor isn’t responsible for it either despite being its chief beneficiary a point I make in an earlier post.

They then categorcally and effectively deny a litany of accusations that the DIFCI alleges but does not substantiate. For example the existence of a conspiracy between Dr. Omar and Barazi is alleged but no evidence is provided other than the fact they both received bonuses which they might well have done without a conspiracy.

The central attack on Barazi in the counterclaim is an allegation that Bisher justified a bonus on the strength of a $60 million realized gain when in fact the DIFCI had an $80 million loss. The DIFCI insinuates that this is a misrepresentation similar to accounting fraud. The argument on the DIFIC side is deceptively simple and the Barazi counterargument is obfuscatingly complex. In sum Barazi makes the following arguments:

1.) It is not formally necessary to actually make money to be paid a bonus
2.) Dr. Omar could decide bonuses at his sole discretion
3.) DIFCI executives benchmarked themselves against payout rates based on a study by Manpower (which implied a 20% payout rate) and their own experience of private equity (which implied a 50%) payout rate.
4.) Given these benchmarks their decision to pay themselves 10% of realized gains after $60 million was conservative.
5.) The decision to base the payouts on realized gains was made because it was conservative
6.) The payouts were made based on unaudited results which it was believed would not be materially different once the audit was completed.
7.) The discrepancy which is pointed out by the DIFCI counterclaim is the result of confusion about the chronology of when the audits were completed and...
8.) Some confusion which arose regarding the accounting treatment of two very large transactions: Bourse Dubai and the Deutsche Bank trade.

A few things stand out. No private investor would pay Bisher and Dr. O 50% fees to manage a PE fund. They had no track record and, as events have shown, would have been wiped out before they were able to create one. That said I personally don’t think their compensation of 10% was too outrageous. I have no view of the issues regarding chronology or realized vs. unrealized gains. Personally I don’t think they’re material. I do have to say that the fact that they contributed the DIFX to bourse Dubai at a valuation in the hundreds of millions justifies a bonus at least twice what they actually got. Don’t get me wrong, I dearly loved the DIFX and I spent nearly a fifth of my working life on it so I have every reason to claim it was more valuable than it was but to get the price they got for it was a miracle.

All in all I think they at least do a pretty good job of explaining in minute detail why the simplistic DIFCI contention of fraud is not what it seems on its face and this should sow a lot of doubt in the minds of the judge.

DIFCI also alleges that Barazi asked for a personal loan after they had been banned and characterizes this as a breach of his fiduciary obligation. More damning they allege that he agreed to buy billions worth of off plan real estate without conducting due diligence another grave breach of fiduciary obligation. The defence regarding the loan is pretty straightforward. Dr. Omar had the right to grant them, he did and Bisher paid it back within weeks of being granted it. Case closed. They also make short work of the allegation of the Pearl due diligence by producing text from the agreement that allows DIFIC to back out ex post facto if their due diligence turns up a material issue even though it is going to be conducted after the first payment is made.

So, all in all, the response from Barazi and Shafiq is a pretty effective refutation of the counterclaims of DIFCI. In cases where they can just shoot down the DIFCI they do it with dispatch and in areas where there is some nuance they seem to have used the “if you can’t convince them, confuse them” strategy so sow doubt about the veracity of the DIFCI claim. As effective as the overt defence buried in the document are two covert defences which will come into play if the DIFCI press their case.

The less powerful one partially emerges in the section on the due diligence. The document points out that in the fall of 2008 the Dubai real estate market was in free fall and the prospects for Cityscape, the annual real estate conference were grim. Then it says “Mr. Barazi was instructed that DIFCIL should make a substantial property investment in a development in the Dubai Technology and Media Free Zone known as “Dubai Pearl” and owned by Pearl Dubai FZ LLC which might be announced before the start of Cityscape in that year." This is not a surprise but it sure does shed some light on why that due diligence was not done before the transaction was executed. What it does not shed light on is who precisely it was that instructed Barazi: the sentence is in the passive voice. The subject is secret, that is until Barazi and his lawyer choose to reveal who precisely it was that was seeking to have DIFCI create a false impression of real estate demand in Dubai by channeling billions of dirhams borrowed by the state into privately owned off plan development. Whoever that was now has a real interest in Barazi not getting prosecuted.

My favourite however comes much earlier in the document. In my first post on this subject I thought it was really odd that the DIFCI counterclaim cited a Gulf Business story about the release of Dr. Omar as evidence that Barazi should have known that he was under investigation. I thought that was preposterous and so does the Barazi legal team who point out the obvious that it does not oblige him to admit any knowledge of the “nature or extent of such investigations as may have been and/or still are being conducted by the DGAT, or as to the alleged charges brought against Dr. Omar or any other employee of the DIFC.”

That’s all well and good but the final clause conceals the knock-out blow: “If and insofar as DIFCIL may seek to assert the truth of (i) any such report (ii) any such investigative findings and/or (iii) any charges that have been laid against any person, they will be put to strict proof of same.” (emphasis mine) This is code for: “if you attempt to pursue me for fraud I will use the higher burden of proof within the DIFC legal system to attack your actions against Dr. Omar in Dubai proper and, (considering we can assume Barazi and Dr. O are in constant contact,) I will very likely be able to show that YOUR ACTIONS AGAINST DR. OMAR HAD NO LEGAL BASIS WHATSOEVER AND THEREFORE ARE INDISTINGUISHABLE FROM EXTORTION.”

What’s my name fool. What’s my name.

So then it will come down to just how much embarrassment the Dubai establishment is willing to take at the hands of Bisher Barazi. I’m not sure, what will happen. They might cave and pay him to go away, or they might say, “Listen little man, its not a secret that this is an autocracy and we can dispose of Dr. Omar as we like. As for public opinion, try to imagine how little we care. As for you, if we don’t win in the DIFC we’ll get you in Dubai proper so either way you’re going to jail. Enjoy.” It may turn out that Barazi, with his elaborate overt and deviously subtle legal arguments, has done nothin more than bring a very elegant knife to a gun fight. Either way the stakes are high for all involved. It’s going to be interesting.

Tuesday, August 3, 2010

So I'm not sure what a "Cascade Agreement" is but I think it has something to do with a waterfall. Hey! Look! There goes a Damas shareholder!

The long suffering shareholders and creditors of Damas are now able to see the full extent of the damage that has been done by the Abdullah Brothers. The annual report puts a brave face on things. With justifiable pride they point out that the company earned 9.8 million AED not including extraordinary items. This grain of good news needs to be taken with a pinch of salt, or rather a pillar of salt because those extraordinary items weigh in at 1.9 billion AED. So if Damas can keep up the good work, they’ll have repaired the damage from these one off write downs in 200 years. Unfortunately for the creditors, and fatally for the shareholders, Damas’ auditor said the company has to come up with a restructuring plan by the end of the month or it may close its’ doors.

I have to admit that in continuing to write about The Great Damas Heist I feel a little bit like George Orwell in “Shooting an Elephant.” I’ve written so much about it that people seem to expect me to continue even though the story has its’ edge because it is obvious how it ends. Alas, my inbox is full of requests, and some of you are new to my writing through its recent syndication. So I’ll point out a few things and tell you how it’s going to end.

The first thing you have to do is get around the Dubai Newspeak that is used to describe what has gone on with regard to the “unauthorized transactions.” They are universally described in the Damas documents and in the press as monies “borrowed” or “owed” by the Abdullah Brothers. The documents in the DFSA undertaking demonstrate that the at the time of the transfers the Abdullah brothers were not obligated to pay the monies back nor were they charged interest. From my perspective an unauthorized interest free loan for an indefinite period is called “theft.” This makes it easy to interpret their actions through the simple expedient of lip reading. If their lips are moving, they’re lying. If their lips are not moving, they’re stealing.

The next thing you have to do is connect the dots that the DFSA is unwilling and the Dubai press is unable to connect. The first thing that stands out is how ridiculous the continued involvement of the Abdullahs as advisors to the company because of their “relationships” and “reputation.” Their reputation for fraud caused a massive liquidity crisis.

The brothers “borrowed without authorization or interest for an indefinite period” or “stole” depending on your frame of reference, two tons of gold from Damas. Interestingly it turns out that the gold that the Abdullah brothers stole was not even the property of Damas. Damas had borrowed it from other merchants and banks. When the other merchants and banks discovered that the Abdullahs were able to simply drive up in a truck and make off with the gold they had lent to Damas they quite reasonably either called in or demanded substantially greater security against the loans. This in turn caused a massive liquidity crisis at Damas which itself resulted in further losses.

It would seem to me that given the fact that the Abdullah Brothers reputation for theft has made it impossible for Damas to acquire the raw materials of its main business on commercially favourable terms would be a pretty good reason to exclude them from the management of the company even in an “advisory” capacity. The people who say that the business depends on reputation are not wrong but the Abdullah’s have a reputation which is commercially fatal to the business of Damas, yet there they are back in the saddle. Now wait a minute you say, doesn’t Damas have an entirely new board? Aren’t the Abdullah Brothers working in a “non-executive” capacity? Surely this will put the gold lenders at ease. Personally I don’t think so. Anybody who has two tons of gold stolen out from under them is going to be understandably sceptical. There was a board at the time the Abdullahs absconded with the gold last time, what makes this board different. They didn’t even have the willpower to stand up to the Abdullah Brothers and keep them out. I’m sure it wasn’t their idea to bring them back in.

There are also some interesting items in the write down list. One of them is the $80 million Dubai Ventures loan. This was money that the Abdullah Brothers had Damas lend to Dubai Ventures, a private equity firm, to invest in the Damas IPO when it turned out that not enough buyers could be found to give the Abdullahs the valuation they wanted. This created the illusion of interest at the higher price and enough of it to clear the 25% hurdle of independent investors necessary to conduct an IPO on the DIFX. Of course since the shares were purchased with Damas’ own money they were not at all independent. This effectively rigged the book build (auction) and forced the foreign investors to overpay. This helpfully increased the amount the Abdullah’s were able to steal. And of course whose money was used to force the shareholders to overpay? Thiers. At least that’s what it looks like now that Dubai Ventures won’t be paying that loan back. Who owns Dubai Ventures? Dubai Holding. Who owns Dubai Holding? Sheikh Mohammed bin Rashid Al Maktoum the Ruler of Dubai. Naturally Sheikh Mohammed is not going to take the hit, the Damas shareholders and creditors will be doing that. Dubai wins again! Thanks for playing gentlemen shareholders. Can we interest you in some off plan real estate?

Another interesting item that they are reserving against are the shares of Damas that the Abdullah Brothers pledged in the event that they cannot repay the loans. Apparently there are some issues with transferring those shares and so they cannot be properly valued. I pointed this out quite some time ago.

Finally, and unsurprisingly Damas thinks it wise to reserve against the possibility that the Abdullah Brothers will not in fact pay back the money and the gold that they “borrowed indefinitely with neither interest nor authorization.” This makes a lot of sense considering that they’re quite a bit overdue with regard to their payment obligations under the Settlement Agreement. There is even some talk of shredding the Settlement Agreement upon which the DFSA unenforced enforceable undertaking is based in favour of something called a “Cascade Agreement.” I’m not really sure what that means but I like the sound of it. It reminds me of going over the falls in a barrel. Joking aside apparently the Abdullah Brothers owe money to other parties aside from Damas. Apparently what they did was steal money from Damas, use that money as a down payment on some real estate and borrow the rest of the purchase price against the asset. That means that the Abdullah brothers, and with them the Creditors and Shareholders of Damas, are behind the banks in the capital structure of these investments. This is what is meant by the Dubai Newspeak “uncertain title.” If you put 20% down on real estate that has declined 50% in value using funds you have stolen from a company you control your equity has been wiped out and so you no longer have title. Nice.

It seems that the parties involved have decided to indulge themselves in the fiction that if they just don’t sell now but wait a while all will be well. While it is perfectly understandable that this is not the optimal time to liquidate Dubai real estate, and I’m sure the banks would agree, the fact remains that this is beside the point. If the Abdullah Brothers investments in real estate using stolen and borrowed funds are underwater so be it. The remainder of the Abdullah fortune should be being auctioned off and the proceeds should be going to Damas. That is not happening. The fact that the investments made with the “unauthorized interest free loans of indefinite duration” have been wiped out does not mean that the Abdullahs did not steal the money. They did. They should be on the hook for it and the DFSA and the Dubai Courts should be liquidating their personal assets in order to pay back the creditors of Damas. ALL their assets not just the ones that they purchased with Damas money supplemented by banks.

But of course this will not happen. The Abdullah Brothers are rich and connected Emiratis. They won’t have to sell their assets, they stole almost 70 years worth of earnings from Damas in 18 months that should last them a good long time. The Damas Creditors will probably roll the debts in the hope that something can be collected over time but they will be disappointed. The shareholders will be wiped out entirely. This is because the shareholders are unconnected international investors. They bought into the idea that inside the DIFC they would be operating in a legal environment that would protect them supervised by a regulator that was operating according to international best practice. Well they won’t make that mistake again.

Monday, August 2, 2010

Ban the BlackBerry today, keep the Indian Navy Away-- A fanciful conspiracy theory from wallstwtf

I want to write a few words about the potential blackberry bans in the UAE and potentially Saudi Arabia. As a person who sleeps with my blackberry under my pillow my first reaction was one of horror at the idea that the blackberry email functions will no longer work on the UAE and perhaps Saudi. On the other hand, I do remember how nice it was to be unreachable while I was in the Arab world when I first began travelling there regularly in 2005. So while the downside will be reduced productivity this will be balanced by the chance for the bankers who visit Dubai to get an extra martini unmolested by the folks in back in London.

I want to take a minute to think a little more deeply about what this means. The issue it seems is that the nature of the blackberry encryption and network organization makes it impossible for the Emirati security services to scan the communications of blackberry users without the cooperation of Research in Motion, the maker of the device. What’s more given the structure of the network and the jurisdictions in which RIM operates the UAE is concerned that it might not be able to use the local legal systems in which it operates to compel RIM to cooperate and hand over data.

OK, so it’s well known that the Emirates are absolute monarchies and it’s not really a secret that they monitor electronic communications within their territory. This is evident in a variety of ways from the occasionally annoying fact that many websites are blocked to the extremely efficient exposure of the Mossad hit squad earlier this year which demonstrated the impressive capabilities of the Emirati counter-espionage services. That said I think this episode is still somewhat revealing.

First of all it shows the willingness of the Emirati government to inconvenience the people who make their living and their homes in the Emirates as well as the international business community. There are 500,000 blackberries in use in the UAE or almost 10% of the population uses them. They are particularly prominent among the international business community which has increasingly been making Dubai the regional business hub. It also put the Emirates which have carefully cultivated an image of openness in a position where Qatar, which announced that it has no intention of limiting blackberry use, to tweak them.

This was also sure to get a lot of press, which it is indeed getting. That press is more favourable than say the issues Google had in China but this is largely because of the presumption that the new restrictions will be used to cut down on Islamic extremism and Iranian sanction busters. Interesting how the freedom of speech and the rights to privacy are more important in American adversaries than in our allies. A similar crackdown on facebook or twitter in the Islamic Republic of Iran would no doubt cause a great outcry. Well, as a famous American once said, a foolish consistency is the hobgoblin of little minds.

Personally I think that presumption is largely misplaced, it is not impossible for the UAE to gain access to the data that is carried over blackberries they would simply be subject to judicial review in Canada. Presumably if what they were after were terrorists or sanction busters they could expect this cooperation. No, they want to be able to scan all secrets for the same reason that Iran and China want to crack down on the use of information sharing, they want to stifle domestic opposition. This is an acute problem in the Emirates.

The analogy I like to use for this is Sparta and the Helots. If you are a classical scholar or have watched the movie “300” you will know that the Spartans had the best and most effective army in ancient Greece. Why was this? It was because the Spartans had, years before, conquered and enslaved another people called the Helots. The Helots outnumbered the Spartans by a substantial margin. So the Spartans developed a highly militarized culture which was designed to terrorize the Helots into subservience and it worked. In addition the Spartans were also able to intimidate the other Greek city states eventually destroying the power of Athens in the Peloponnesian War.

The demographics of the Emirates are similar to those of Sparta. The Emiratis themselves are vastly outnumbered by expatriate workers. A few tens of thousands of those labourers are the white collar European or American workers for international firms, who will be most inconvenienced by this. The teeming majority of them however are workers from the subcontinent and Southeast Asia who while substantially better off than most of their countrymen who are still at home are nonetheless at the very bottom of the social ladder in the Emirates. They are therefore potentially the most subversive force with which the regime has to contend and the one with which the Canadian government is least likely to cooperate with wholesale monitoring.

When I first noticed the massive demographic imbalance I wondered why the Emiratis were so militarily complacent. I would have expected mandatory military service and lifetime membership in the reserves in a country where the natives are outnumbered ten to one by foreign labourers who earn less than 10% of the incomes of the locals. Add to this that the mother country of this relatively poor and occasionally persecuted minority is a major power with increasing capacity for power projection. Then someone explained to me the two reasons why this was the case. First, the Emirates are functionally an American protectorate and if there were ever a threat to the regime the American forces stationed there could be relied on to protect the various ruling families against a violent upheaval. The second is that while largely a distant and benign force in the lives of white collar expatriates the Emirati government is a coercive police state in the lives of many of the immigrants from the sub-continent and uses its power of communications to thwart efforts by them to organize.

So why have the Emiratis chosen this moment to square off against RIM over control of the information sent across the blackberry network? Why now and not 2005 or 2007? Could it be that the Gulf Arabs are watching events in the US and beginning to question the American commitment to their security? The American departure from Iraq is imminent. America seems to be reconciling itself to the existence of a nuclear armed Iran. In Afghanistan the destruction of the American commander by Rolling Stone of all thins and the release of 90,000 classified documents by wikileaks is laying bare the fact that American will is being sapped even with regard to the nation from which the 9-11 attacks were launched. Is it possible that these signs of American fatigue in the Arab world are leading governments in the region to realize that they are going to have to be more aggressive in the suppression of domestic unrest solely through the use of domestic resources? It's farfetched but it’s something to think about.